Buds and Booze: Lessons from Prohibition Could Inform Marijuana Industry

07 Jun 2018

Buds and Booze: Lessons from Prohibition Could Inform Marijuana Industry

Reading the leaves regarding the potential decriminalization of marijuana is confusing and contradictory; however, one certainty is that the intoxicating combination of a cash-rich industry and a multitude of sometimes conflicting regulations creates the perfect environment for a range of frauds—from accounting fraud such as money laundering to investor fraud and counterfeiting—to flourish. As the tide of public opinion continues to roll towards decriminalization and money continues to pour in, those working to ensure the industry operates safely, legally, and ethically can derive interesting lessons from the almost-14-year-long failed “social experiment” known as Prohibition.

Conflicting Regulations Create Opportunities for Fraud

According to Forbes, the marijuana industry was a $9.7 billion industry in 2017 and is expected to grow to $57 billion by 2027. This growth is expected despite the fact that marijuana remains a Schedule I drug (along with ecstasy, LSD, and heroin) and is illegal at the federal level. In an ever-growing disconnect, however, medical marijuana is legal in 29 states, and nine states and Washington, DC, have legalized marijuana for recreational use for adults 21 and older. With recent medical studies indicating the regulated use of marijuana may help stem the rising opioid addiction helping to bring the issue of legalization to the forefront, careful diligence and oversight will be key to creating a safe, legal, and profitable marketplace.

Call it cannabis, pot, ganja, weed, or any of a host of other names, conflicting regulations concerning marijuana have created burgeoning black and gray markets. Limits on the amount of marijuana that can be legally sold in the market by individual growers in Colorado, for instance, have created a shadow market for the substance that cannibalizes the legal marijuana trade in that state. The federal prohibition against transporting marijuana across state lines has left nearly a million pounds of marijuana moldering in Oregon, depressing revenues and decreasing the taxes the state is able to collect. In recent months there has been a significant uptick in the number of deaths and severe illnesses tied to synthetic marijuana products laced with poison.

It is hard to ignore the parallels between the current marijuana market and Prohibition, a period when gangsters and organized crime in general were the only big winners. According to legend, Arnold Rothstein, who was reputed to have rigged the 1919 World Series, set up his “office” at Lindy’s Restaurant in Midtown Manhattan and made a fortune bringing alcohol across the Great Lakes and down the Hudson River. And Al Capone’s multimillion-dollar operation in bootlegging, gambling, and marijuana dominated the era in Chicago. Although there is little question that alcohol consumption declined during Prohibition, the law had unintended consequences. Thousands died from drinking tainted liquor. During Prohibition, tax revenues decreased and unemployment increased as alcohol- and entertainment-related businesses closed their doors. Prohibition lasted just 14 years.

Today, a number of states in which marijuana is legal have disclosed that tax revenues are less than forecasted, and lawmakers suspect this is due to an underreporting of revenues. Many believe this underreporting stems from the fact that federal regulations make it difficult, if not impossible, to bank the industry, creating an all-cash industry and along with it opportunities for fraud, money laundering, and tax evasion. Even the few institutions that have historically accepted marijuana money are changing their minds. In April 2018, the Illinois-based Bank of Springfield rescinded its decision to bank those involved in the marijuana industry, giving its clients until mid-May to remove their funds. The cash nature of the business is unlikely to change while marijuana remains federally illegal.

Investor fraud is also growing. In 2015, in order to bypass the Oregon Health Authority’s Medical Marijuana Dispensary Program (MMDP), Portland-based pot dispensary Cannacea used a fraudulent letter from the MMDP to bilk investors out of hundreds of thousands of dollars. The largest marijuana fraud case in Colorado history is winding its way through the courts as investors accuse management company Harmony & Green and its CEO of misusing their funds. Fraud is likely only to increase, given the fact the industry received its first billion-dollar valuation when Captor Capital announced it would invest $30 million for a 3 percent stake in California-based MedMen Enterprises. With increased opportunities for fraud, diligence is vital.

Shared Federal and State Oversight Would Strengthen Industry, Discourage Fraud

In December 1933, the ratification of the 21st Amendment ended Prohibition but did not return the industry to its pre–18th Amendment status quo. Instead, the amendment gave broad authority over the regulation of alcoholic beverages to the states and limited the power of the federal government to intrude upon state alcohol beverage control policies, creating the industry as we know it today with its mix of federal and state laws, as well as its potential for fraud.

There are indications that the federal government may be willing to take up the issue of marijuana legalization. Earlier this year, former U.S. Speaker of the House John Boehner (R-OH) made front-page news when he reversed his long-held opposition to legalizing marijuana, tweeting “I’m joining the board of #AcreageHoldings because my thinking on cannabis has evolved. I’m convinced de-scheduling the drug is needed so we can do research, help our veterans, and reverse the opioid epidemic ravaging our communities.” And recently, the U.S. Congress has begun to consider marijuana legislation. On April 20, 2018, known as “Weed Day” because the date corresponds with the numerical code for marijuana, Senate Minority Leader Chuck Schumer (D-NY) introduced a bill to decriminalize marijuana, and on June 7, 2018, Senators Elizabeth Warren (D-MA) and Cory Gardner (R-CO) released a long-awaited bipartisan marijuana legislation reform bill. Their bill does not seek to legalize marijuana but instead proposes an amendment to the Controlled Substance Act, protecting people who choose to use marijuana as long as they comply with local state or tribal laws. Even U.S. Attorney General Jeffrey Sessions has softened his initial stance, stating that federal prosecutors would not prosecute routine marijuana crimes. Elsewhere, Canada is poised to become the first G7 nation to make marijuana legal.

As we move towards the next election cycle, one in which marijuana initiatives are expected find their way to a number of states’ ballots and possibly come under federal consideration, the success of the marijuana industry relies on thoughtful oversight and appropriate diligence in order to ensure it operates safely, legally, and ethically.